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Foul Weather Austrians
I am puzzled by the resurgence of Austrian Business Cycle theory among Sachs, Krugman, Baker and many others who you would not ordinarily associate with the theory. Sachs, for example, writes:
...the US crisis was actually made by the Fed... the Fed turned on the monetary spigots to try to combat an economic slowdown. The Fed pumped money into the US economy and slashed its main interest rate...the Fed held this rate too low for too long.
Monetary expansion generally makes it easier to borrow, and lowers the costs of doing so, throughout the economy. It also tends to weaken the currency and increase inflation. All of this began to happen in the US.
What was distinctive this time was that the new borrowing was concentrated in housing....the Fed, under Greenspan's leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash.
What is puzzling about this is two-fold. First, there is no standard model that I know of (say of the kind normally taught in graduate school) with these kinds of results. Second and even more puzzling is that the foul-weather Austrians don't seem to draw the natural conclusion from their own analysis.
If the Federal Reserve is responsible for what may be a trillion dollar crash surely we should think about getting rid of the Fed? (n.b. I do not take this position.) The true Austrians, like my colleague Alvaro Vargas Llosa, have long taken exactly this position. So why aren't Sachs, Krugman et al. calling for the gold standard, a strict monetary rule, 100% reserve banking, free banking or some other monetary arrangement? Each of these institutions, of course, has its problems but surely after a trillion dollar loss they are worthy of serious consideration.
Nevertheless, I haven't heard any ideas, from those blaming the crash on the Fed and Alan Greenspan, about fundamental monetary reform. (Can Sachs, Krugman et al. really believe that it was Greenspan the man and not the institution that is to blame? That seems naive.)
Instead, the foul weather Austrians seem at most to call for regulatory reform. But that too is peculiar. Put aside the fact that banking is already heavily regulated, have these economists not absorbed the Lucas critique? In short, suppose that whatever regulation these economist want had been put in place in earlier years. Would the crash have been avoided or would the Fed have simply pushed harder to lower interest rates? After all, the Fed lowered rates for a reason and if the regulation reduced the effectiveness of monetary policy in creating a boom well then that just calls for more money.
Posted by Alex Tabarrok on April 2, 2008 at 07:43 AM in Economics | Permalink
Comments
we just need the *right* greenspan in there, alex. c'mon, man.
Posted by: shawn at Apr 2, 2008 8:21:23 AM
Expanding on Shawn's comment, there's a certain segment of the population who believes that government is an unmitigated force for good. Except when *those* guys are in control. When bad things happen, it's those guys fault, not a failing of the institution.
If per chance *our* guys are in charge when bad things happen, it's still not a failing of the institution nor is it the fault of our guys. Instead, *we* were a victim of forces beyond our control and if only we can bring those forces under government purview, then all will be right in the world.
==========
Krugman pretty clearly falls into this camp, which is why he doesn't view current problems (such as they are) as a fault of the institution and views them instead as the fault of the wrong team managing the institution.
Posted by: Jody at Apr 2, 2008 8:33:02 AM
What was distinctive this time was that the new borrowing was concentrated in housing....the Fed, under Greenspan's leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash.
If the housing bubble was caused by low interest rates and is the Fed's fault, then how do they account for the greater run-ups in housing prices elsewhere? An excerpt from the recent End of the Irish Miracle piece:
"The average house price topped $490,000 at the beginning of last year, an increase of more than 300% in just over a decade, compared with 130% in the U.S."
Here's the situation for the UK:
"UK house prices 'nearly tripled'. Average house prices have nearly tripled across the whole country during the past decade"
http://news.bbc.co.uk/1/hi/business/6090972.stm
And what about the euro-zone as a whole?
"The euro area average index of real housing prices has risen almost as much as that of the US and is now (as that of the US) about 40% above its 30-year average."
http://www.voxeu.org/index.php?q=node/642
But I'm sure that Krugman, et al know this perfectly well. So what game are they playing? Election year politics, obviously (and in that game an argument doesn't have to right to be useful).
Posted by: Slocum at Apr 2, 2008 8:39:19 AM
Provide the context the small segments you quote and overanalyze. Dumbing down Krugman's critique of the Fed to one sentence and the drawing a conclusion like 'he must call for the Fed to be abolished' is facile.
Posted by: Mark at Apr 2, 2008 8:56:38 AM
The whole Austrian thing is too inside-baseball for me.
When an institution works pretty well for a century, maybe it works pretty well, in general. Maybe "taking away the punch-bowl" is a critical piece of making it work.
I think the bigger, scarier, issue is that congress is considering props to keep the house-bubble inflated(!)
Posted by: odograph at Apr 2, 2008 9:29:55 AM
"Can Sachs, Krugman et al. really believe that it was Greenspan the man and not the institution that is to blame? That seems naive."
Good point. Any POTUS would have invaded Iraq post 9/11, for example.
Posted by: meter at Apr 2, 2008 9:30:28 AM
These men are not writing as economists. They are writing for the political sphere of debate. When they have written for the technical sphere, I bet they said different things.
Also, remember that these are people who generally see the world as needing to be controlled from the top. When something bad or good happens, the top is where they will look. That's the paradigm they follow.
Posted by: bobvis at Apr 2, 2008 9:32:56 AM
Very few people who want to retain their status as "serious" thinkers will publically call for the same things Ron Paul did, for fear of a serious decline in the quality of their groupies being tarred as a "Ron Paul-loving nutjob".
A little more seriously, Austrian economics has a strong normative aspect, but the analytical tools don't necessarily lead to the same normative conclusions. When the Fed actually was trying to keep inflation low, the Austrian's critiques sounded awfully strained. After two large bubbles have popped within 7 years, there's more strength to their arguments, but the political reality is that we aren't going to abolish the Fed anytime soon, so figuring out what the Fed should do (or shoul dhave done) is a more fruitful exercise than calling for its abolition. Ronald Reagan got elected president by calling for the Fed to tighten monetary policy to reduce inflation and the harms following it. Ronald Paul became a laughingstock by calling for the abolition of the Fed.
Posted by: Anthony at Apr 2, 2008 10:04:36 AM
Maybe it's the Ron Paul effect.
Posted by: 8 at Apr 2, 2008 10:06:33 AM
"When an institution works pretty well for a century, maybe it works pretty well, in general"
Over the last century we have had a Great Depression and a number of large recessions. Why do you call that working well?
Posted by: assman at Apr 2, 2008 10:11:19 AM
Slocum, anecdotally it seems to me that the EU runup in RE prices lagged the US.
Spain, for example, started to crumble after our market did.
Posted by: meter at Apr 2, 2008 10:15:25 AM
I was rounding-up, using the post-Depression Fed as my starting point ;-)
Posted by: odograph at Apr 2, 2008 10:15:39 AM
I think the difference between Ron Reagan and Ron Paul had more to do with their demeanor than their policy prescriptions. True, Reagan slowly moderated from his initial Reason Interview stances, due to the realities of Washington, but his platform was not timid, when running against Carter and the 1970s economic concepts of Galbraith et al.
The difference is that Ron Reagan spoke with pride and humor about a strong free market America and a crazy, foolish and evil communist Russia; while Ron Paul whines about inflation and the Fed.
Posted by: liberty at Apr 2, 2008 10:19:03 AM
"When the Fed actually was trying to keep inflation low"
Depends what you mean by keeping inflation low...according to the productivity norm there should be deflation when productivity increases:
http://macromarketmusings.blogspot.com/2007/09/mark-toma-points-us-to-knzn-who-is.html
http://www.cato.org/pubs/journal/cj10n1/cj10n1-14.pdf
Posted by: assman at Apr 2, 2008 10:20:20 AM
From Odograph:
When an institution works pretty well for a century, maybe it works pretty well, in general. Maybe "taking away the punch-bowl" is a critical piece of making it work.
Then, later:
I was rounding-up, using the post-Depression Fed as my starting point
So, were you then conceding the point that maybe the Fed has not worked well at all? One could also add in all the central banks that have failed in the past, and the other ones committing the same errors today.
The current crisis will likely pass, but the errors get larger and larger over time as total debt always outstrips total output. Eventually the entire edifice collapses.
As for Krugman and his ilk, they will be inflationist cheerleaders once Democrats are in the presidency. They have no intellectual honesty.
Posted by: Yancey Ward at Apr 2, 2008 10:43:02 AM
Just because you believe money was too cheap doesn't mean you subscribe to an Austrian-style understanding of central bank policy.
But I doubt money was cheap in the sense of low interest rates. I bet if you really pressed Krugman et al. they would come to agree with Robert Reich: Why did the Fed choose, in the midst of an easing cycle, to also ease lending standards with respect to both documentation and to performance bond (i.e. down payment)?
Any properly functioning market, like a futures exchange, has a type of performance bond embedded. Greenspan threw this baby out with the bathwater of excessively high interest rates, and now Bernanke is left to clean up the mess.
Overleveraging does not occur from low interest rates, it occurs from low lending standards and low margining. A simple 10-20% down payment would have kept stability in these markets.
This is the aspect of the credit process the Fed failed on. It has nothing to do with fiat currency.
Posted by: Alex Reed at Apr 2, 2008 10:45:30 AM
Slocum, anecdotally it seems to me that the EU runup in RE prices lagged the US.
Spain, for example, started to crumble after our market did.
Yes, but the point is no Greenspan easy-money policies (that allegedly caused the U.S. housing price run-up) have been in effect in the UK and eurozone markets.
Posted by: Slocum at Apr 2, 2008 10:46:41 AM
I'm not getting you, Slocum. Didn't the Fed as we know it only start after the Great Depression? And since then haven't we only had less than catastrophic business cycles?
What if that's as good as it gets?
Now assuredly the current situation with rampant debt is a serious issue, but we could argue it is what comes when the Fed model is overthrown (no punchbowl removal, no banking oversight) rather than what happens when it is adhered to.
... you weren't one of the "free the markets" boys, were you?
Posted by: odograph at Apr 2, 2008 11:07:44 AM
Alex Reed,
I think Tabarrok is correct- keeping lending standards higher, or even raising them would have been contrary to the outcomes desired. If lending standards had been kept fixed, then the low interest rate policy would not have had the desired effect. The Fed would then have had to lower rates even more (or found even more ways to extend credit), and you would have ended up in the same place.
Posted by: Yancey Ward at Apr 2, 2008 11:11:24 AM
You don't sense any tautology there Yancey?
What if, because lending standards and reasonable debt limits were considered important, we had ended up some place else?
Posted by: odograph at Apr 2, 2008 11:15:25 AM
Odograph,
The Fed was instituted in 1913, during the Wilson administration. Though the country was technically on a gold standard, that was, in fact, a fraud, as was demonstrated by 1933's dollar devaluation (another fraud that was demonstrated by 1971's breaking of the final link between gold and the dollar).
No, the Fed get a lot of the blame for the Great Depression, it gets a lot of the blame for the stagflation of the 1970s and the deep recession of the early 1980s, and the present mess is almost entirely blamable on the Greenspan Fed's less-than-zero real interest rate policies.
A central bank can work if you can guarantee that it will maintain a fairly stable monetary unit, but such a central bank has never existed. This suggests that it will never exist. And once you start down the inflationary path, the incentives are to never deviate and to only accelerate the rate.
There are only two options: (1) inflate the debt away and destroy the currency, or (2) allow the debts to be realized and losses assigned to the proper parties. No one in government ever advocates the second of these options.
Posted by: Yancey Ward at Apr 2, 2008 11:25:02 AM
Odograph,
If we were intended to end up somewhere else, then there would have been no artificial suppressing of interest rates in the first place. It is not a tautology, it is a simple recognition of the actual goals of the lower interest rate policies. Higher lending standards were contrary to those goals. If lending standards had not come down, then the Fed would have had to lower interest rates even more, and you would still have ended up with this banking crisis.
Posted by: Yancey Ward at Apr 2, 2008 11:29:57 AM
OK, maybe I'm thinking of the whole matrix of post-Depression institutions and mechanisms which (to my mind) formed a moderate, regulated, market, economy.
That didn't seem to bad to me ... until something happened in the 70's and 80's. And at this point I still see that 70's/80's thing as a breaking point, and inflection from past patterns, rather than the 1913-present rule.
Posted by: odograph at Apr 2, 2008 12:00:09 PM
We want to put all the blame on Greenspan because this allows us to personify the problem -- and personify it somewhere else.
This allows us to ignore the stupidity of homeowners who overleveraged themselves, the fraud or near-fraud involved in passing bad-bet mortgages through the system, the faulty statistical models, the overleveraging of Wall St firms, the "off book" stuff that wasn't far enough "off book", etc. (tired of typing).
Posted by: zbicyclist at Apr 2, 2008 1:26:23 PM
Odograph,
What past pattern? There is no pattern that existed in the past that we don't see today. It is a boom/bust cycle caused by credit expansion and credit contraction. A central bank just makes it systemic.
I realize the past pattern you are trying to identify with is the period of 1950s to the 1970s, but trying to find something unique in that period of boom compared to, lets say, the boom period of 1983- 2000 is just fallacious.
Posted by: Yancey Ward at Apr 2, 2008 1:29:11 PM
